Watch Out for the Cryptocurrency Bubble
Over the last few years I’ve come to know a lot about the various types of investors out there.
Most investors are steady, careful people who seek out the best possible advice before they act. They’re the kind of people who subscribe to the services published by my colleagues here at Banyan Hill. They spend a lot of time trying to understand the investment environment, and have a good sense of the risks associated with any given trade.
Then there are the gamblers. Most of them are also pretty clear about the risks associated with their decisions. Like any good gambler, they take risks — calculated risks.
Then there are the desperate. They are driven by a sense of panic … by the need to make a big score, perhaps to make up for years of financial neglect.
A high proportion of those desperate folks are attracted to cryptocurrencies. The last few days have been tough for them…
The Mighty Fall, Then Rise Again
Many people I know who aren’t involved in the cryptocurrency world were quite surprised two weeks ago when it was reported that ether, an e-currency launched in 2014, had a total market value almost as big as bitcoin.
I admit to being surprised myself even though I pay attention to cryptocurrencies as part of my job.
The reason for that is straightforward: The tendency is to watch the value of an individual unit of a currency. In that respect, bitcoin is way more valuable than ether. One bitcoin is about $2,136 right now. One ether is $175. Bitcoin’s higher price makes it seem like the big kid on the block — which it is, of course, being the granddaddy of all e-currencies.
But there are a lot more ether out there than bitcoin, so despite the former’s lower price, its share of the total cryptocurrency market is nearly 30%.
That’s a pretty big jump: Ether’s share of the cryptocurrency universe was just 5% at the beginning of the year. It reached 30% in June, then crashed over this past weekend: It tumbled about 25% to a low of $140 an ether, down 65% from its record high of $395 set on June 13. It has rebounded somewhat since then.
Bubble, Bubble, Toil and Trouble
Ether has done well largely because it is part of a larger initiative called Ethereum, which seeks to develop new uses for the blockchain technology that underlies all cryptocurrencies.
But it has also benefited from a general rush to cryptocurrencies in the last three years, in the form of initial coin offerings (ICOs).
An ICO is a way to crowdfund the release of a new cryptocurrency. When a cryptocurrency startup firm wants to raise money through an ICO, it sells “tokens” for dollars or bitcoin that can be exchanged for the new currency at some date in the future. Generally, tokens for the new cryptocurrency are sold to raise money for technical development before the cryptocurrency itself is released.
These tokens are similar to shares of a company sold to investors in an initial public offering (IPO) transaction. Unlike an IPO, however, acquisition of the tokens does not grant ownership in the company developing the new cryptocurrency. All you get is a promise of coins to come.
And unlike an IPO, there is little or no government regulation of an ICO.
Early ICO investors are usually motivated to buy the new cryptocurrency in the hope that it will increase in value when released. Ethereum is an example of a successful ICO project that was profitable to early investors. In 2014, the Ethereum ICO raised $18 million in bitcoin, or $0.40 per ether. The project went live in 2015, and in 2016 ether rose as high as $14, with a market capitalization of over $1 billion.
Now ether is at $175. You can imagine how people feel when they realize that had they bought ether at the ICO, every $0.40 they’d invested would now be worth that much.
On the other hand, those who bought ether at $395 a few weeks ago are less impressed.
A Cryptocurrency Wild West
So far this year, there have been around 20 ICOs a month.
You read that right: 20 brand-new cryptocurrencies proposed every single month.
Frankly, that’s crazy. There’s no way all those currencies are going to succeed. But apparently there are plenty of people out there who are either willing or desperate enough to believe that they will, and who hand over money or bitcoin to get a piece of the action.
Those people are the fuel beneath the current ICO fire.
When fuel burns, it disappears. Remember that if you’re ever tempted to gamble on a cryptocurrency ICO.
Editor, The Bauman Letter
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